Amid fast-moving events, Spain’s IBEX 35 (IBEX) closed in negative territory for a third day, dropping 2.6% to 6,090.40. Pressure remained on the country as Egan Jones Ratings Co. — on Tuesday after the market closed — downgraded Spain’s debt to B from BB-minus with a negative outlook.

Shares of troubled lender Bankia SA (BKIA) dropped for a sixth straight day, down 8.6%. Finance Minister Luis De Guindos clarified the government’s rescue plan for Bankia, saying it will raise the 19 billion euros ($23.6 billion) needed for the bailout through sales of government bonds. Spain to sell bonds to pay for Bankia bailout

Separately, the European Commission said it may extend Spain’s deficit goal by a year, giving Spain until 2014 to reduce its budget deficit to 3%.

Mike Ingram, market commentator at BGC Brokers, said the real worries about Spain are whether Bankia’s woes will spill over to the rest of the financial sector and if the government will be able to bail out the banking sector.

“Even if Bankia was at the epicenter of the Spanish property bubble, it’s inevitable there will be some read across to the balance sheets at other banks,” he said, and looked to the European Central Bank to take action.

“If the banks have solvency issues, obviously they will need to recapitalize, but the most pressing need is to reassure domestic depositors. If there’s a flight of domestic deposits, then it’s game over, he added. ”The ECB needs to be the formal lender of last resort, and I think that’s where we’re going. Only institutions like the ECB have the fire power to address the issues the markets are currently worried about.”

Retail and corporate deposits in Spanish banks in April hit the lowest level since the start of the euro-crisis, the ECB said Wednesday.

Further adding to a downbeat sentiment, the European Commission said its economic sentiment indicator for the currency area fell to 90.6 in May from 92.9 in April, the lowest level in 31 months. Euro-zone business confidence slumps in May

Concerns about Spain drove the euro
EURUSD, -0.0509%
down 0.7% to $1.2401 as safe-haven flows again lifted the U.S. dollar.

Safe-haven attraction was also seen in German bonds, where the yield on 2-year government bonds (10YR_GER) edged down to 0.011%, according to Tradeweb.

Both the euro and European equities trimmed losses in midday trade, after the European Commission in a set of reports said the European Stability Mechanism, the euro zone’s permanent rescue fund, may be used for bailing out troubled banks. The commission further called for creation of a banking supervision union. EU sees rescue fund bailout of euro-zone banks

But resorting to the European Stability Mechanism as a means of helping failing banks seems an unlikely scenario, said Paul Kavanagh, partner at Killik & Co.

“I don’t believe anyone has agreed to write a check, and it isn’t a solution, just an idea being thrown out there. It would require some of the stronger nations to increase their contributions to the ESM,” he said, stressing that Germany probably won’t be willing to shovel more money into the rescue fund.

Italy’s borrowing costs rise

Also Wednesday, Italy’s government sold a total of 5.732 billion euros ($7.123 billion) of 5- and 10-year debt at higher borrowing costs than at previous auctions of the same maturities.

In the secondary market, yields on 10-year Italian government bonds (10YR_ITA) jumped 17.4 basis points to 6.068%, according to Tradeweb.

“The auction went as well was as could be expected. Europe is under pressure and it’s unreasonable to expect Italy to buck that trend. It would be interesting to see who bid in that auction — if it was only Italian banks, I would take a more negative view, ” Ingram said.

“Italy has different issues than Spain. Right now, the market is primarily concerned with banking issues in Spain, but if you look at sovereign debt to GDP it’s still looks pretty good, whereas Italy’s got a relatively high debt to GDP,” he said.

On the equities side, the FTSE MIB index (FTSEMIB) dropped 1.8% to 12.872.58.

Greece stocks were also under hard selling pressure, as the Athens General Index (GD) dropped 3.2% to 511.29. National Bank of Greece SA (ETE) tumbled 7.9%.

Bearish on banks

Banking shares traded broadly lower.

In London, heavyweight HSBC Holdings PLC (HSBA)
HBC, -0.38%
slipped 2.1%, while Royal Bank of Scotland Group PLC (RBS) gave up 3%.

German stocks also posted significant losses, with the DAX 30 index (DAX) down 1.8% at 6,280.80. ThyssenKrupp AG (TKA) declined 3.3% as Moody’s Investors Service changed the outlook to negative from stable.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.